Most economists will remember 2014 as the year of Thomas Piketty (bit.ly/1xpn2Qy). But last month, a lesser-known academic from the University of Sussex beat Piketty to win the inaugural New Statesman SPERI prize in political economy.

The list of nominees for the prize, introduced this year by the New Statesman magazine and the Sheffield Political Economy Research Institute (SPERI), included not just Piketty but also other well-known names such as the heterodox economist and bestselling writer Ha-Joon Chang. Ultimately, it was Mariana Mazzucato of the Science Policy Research Unit (SPRU) at the University of Sussex who won the prize for her work on state-led innovation.

Like Piketty, who has challenged conventional economic wisdom on inequality, Mazzucato, too, has challenged mainstream economic thought on entrepreneurship and innovation. Her research shows that the credit for many important innovations in society goes as much to the public sector as to private firms. When it comes to taking really big risks that can transform society, the comparative advantage lies with state-backed entities rather than private entrepreneurs backed by venture capitalists, Mazzucato argues in her writing.

Entrepreneurship and innovation are still among the relatively less understood topics in economics. Joseph Schumpeter, one of the foremost scholars on entrepreneurship, had defined entrepreneurship as the activity that successfully transforms an invention into an innovation. He contended that the process employs “a gale of creative destruction” to replace the existing market structure with a new one. Mazzucato’s work synthesizes Keynesian economics of greater government spending with Schumpeterian philosophy that stresses innovation as a key engine of growth.

The government, in Mazzucato’s universe, is visualized as one which not only sets up the rules for businesses but also actively engages in entrepreneurial activity. The standard argument in mainstream economics posits that governments can only incentivize entrepreneurial activity through taxation, subsidies and so on. But it is the private sector that engages in innovation. In her work, Mazzucato has shown that this dichotomy should be done away with, and points to the public sector roots of innovation by private firms.

When we think of innovation, almost always companies like Google Inc. and Apple Inc. come to mind. They only seem to confirm the conventional wisdom about innovation being the fiefdom of private enterprises. But a closer look at the facts suggests that such a conclusion may not be entirely true. Apple, for example, was funded by a state-sponsored programme in the US known as the SBIC (Small Business Investment Company). Similarly, Google’s famous search algorithm was financed by an NSF (National Science Foundation) grant. LCD and lithium-ion battery are other notable examples of state-supported technologies. That the state has played an important role in the story of technological advancement and economic growth is something we should know more about.

In her widely acclaimed 2013 book The Entrepreneurial State, Mazzucato attempts to dispel some of the myths regarding innovation-led economic growth. The first myth according to Mazzucato is that innovation and growth follow from research and development (R&D). A broad set of studies suggest that the presumed relationship between R&D spending and growth is at best ambiguous—some findings suggest a positive relationship whereas other studies find no significant change in growth as greater R&D investment is made. In his firm-level studies based on data for firms in the UK, the late Paul Geroski and his colleagues show (mintne.ws/1Apnwv5) that large companies enjoy their status due to higher spending on R&D and advertisements. Hans Lööf of Royal Institute of Technology, Sweden, and Almas Heshmati of IZA (Institute for the Study of Labor), on the other hand, did not find a robust relationship between R&D and firm-level growth (mintne.ws/1u2VmBo).

The second myth Mazzucato busts is about the importance of small firms for innovation, and by extension, for growth and employment. Two main arguments are often made in favour of small firms. Firstly, a large number of small firms entering a market enhances competition and promotes entrepreneurship. Secondly, since small firms are largely labour-intensive, they boost employment. The biggest challenge to this argument comes from a 2009 study by economists Chang-Tai Hsieh, of University of Chicago, and Peter Klenow, of Stanford University, which finds that (mintne.ws/1xbTl6K
) Indian firms tend to be less productive than the ones in the US due to misallocation or misuse of resources by too many small and low-productivity enterprises. A recent National Bureau of Economic Research working paper (mintne.ws/1xiy3ma), by Shanti Nataraj of Rand Corp., Leslie Martin of Melbourne University and Ann Harrison of Wharton School, complements the Hseih-Klenow findings. The paper shows that the policy of de-reserving space for small-sector enterprises between 1997 and 2007 led to greater employment and wage growth. Younger factories outdid the old ones and large firms outperformed the smaller ones, the empirical analysis shows.

“Rather than giving handouts to small companies in the hope that they will grow, it is better to give contracts to young companies that have already demonstrated ambition,” suggests Mazzucato in her book. “It is more effective to commission the technologies that require innovation than to hand out subsidies in the hope that innovations will follow.”

The next myth Mazzucato attacks is the overblown case for the venture capitalists. There is no doubt that venture capitalists play an important role by funding projects during the incubation phase. However, they may often be very selective in their investments and eschew risky projects. Mazzucato’s research shows that venture capital (VC) investments tend to be concentrated in limited areas of high growth and low technological complexity. Although VC funds are supposed to last for a specific period (ten years), they usually exit much earlier, making it difficult for long-gestation ventures to depend on them. Mazzucato argues that the government should therefore step in with its resources when an innovation is costly, has a long gestation plan, or involves risks that private funders can’t stomach.

Mazuccato’s work has revived the ideas first expressed by the philosopher Karl Polanyi, who argued for the primacy of the state in creating a network of knowledge and markets in his 1944 book, The Great Transformation. Writing at about the same time as Schumpeter, Polanyi stressed the role of the state in promoting and pushing for greater innovation. The Nobel-winning economist Joseph Stiglitz, in the introduction to a reprint of Polanyi’s book, explains that Polanyi’s main focus was to create a balanced approach where government interventions work in tandem with a growing market system. This neither fits with the theories of free-market nor with those of classical Marxists. Polanyi contended that “the road to the free market was opened and kept open by an enormous increase in continuous, centrally organized and controlled interventionism”.

Mazzucato has helped bring Polyani’s ideas centre-stage. Here’s how she describes the process, “Whether the state is making an investment in the internet or clean energy in the name of national security or in the name of climate change, it can do so on a scale and with tools not available to businesses (i.e. taxation, regulation). If a central hurdle to business investment in new technology is that it will not make investments that can create benefits for the ‘public good’ then it is essential the State do so—and worry about how to transform those investments into new economic growth later.”

Mazzucato’s research offers several important lessons. We need to perhaps pay more attention to building the right set of institutions and organizations within the government that are willing to invest in high-growth, high-risk areas. A clear framework for risk-reward relationship should be in place to cover for the uncertainty in returns. This will require reforms that move away from relying entirely on market forces for innovations to a mixed strategy.

The well-known economist Albert Hirschman wrote in The Rhetoric of Reaction about three obstacles posed by conservatives to such reforms which entail a greater role for the state: perversity (a reform will end up having unintended consequences), jeopardy (reforms are costly) and futility (a reform is literally impossible given that problems cannot be solved). Economic progress depends on how we deal with these three reactions and Mazzucato’s framework offers us a refreshingly new approach.

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